Lingering thoughts on the sale of scrap material by PEZA entities

The Court of Tax Appeals (CTA) has decided and Philippine Economic Zone Authority (PEZA) companies have accepted that they will be paying regular corporate income tax on the sale of scrap material.

This change in interpretation came about after the CTA in division issued its decision in the case of Nidec Copal Philippines Corp. (Nidec), a PEZA-registered enterprise, and which was affirmed by the CTA en banc in 2008. Prior to this case, the BIR has been ruling that income from sale of scrap arising from the registered activity is subject to the same tax regime as the registered activity.  

Why can’t I put this issue to rest?

I have three lingering thoughts, simple thoughts, actually:

First, I’ve been thinking that the PEZA rule used as basis for the decision applies only on the taxation of movement of goods in and out of the zone, hence should involve only VAT and excise tax and may not be used as basis for determining the income tax treatment of sale of scrap.

Second, I was hoping that the sale of scrap can be viewed as just a recovery of an amount previously expensed and hence, shouldn’t the company pay tax based only on the tax benefit previously enjoyed (5% tax or zero tax if under income tax holiday).

Third, the simple layman question of why a generally unavoidable consequence of the registered activity cannot be considered part of the registered activity?

Let me share my simple thoughts.

Nidec argued that, pursuant to PEZA Memorandum Circular No. 2005-32 dated Sept. 15, 2005, its sale of scrap materials, which arose from the manufacture of its registered products, is subject to the 5% preferential tax rate and not to the normal corporate income tax.

The Commissioner of Internal Revenue, on the other hand, took the position that since Nidec’s sale of scrap materials is not one of its registered activities, the same is subject to the regular corporate income tax rate, then 34%, pursuant to Section 8, Rule VIII of the Implementing Rules and Regulations (IRR) of Republic Act No. 7916.

The CTA en banc ruled that, between the PEZA IRR and the PEZA Circular issued by the director-general, the IRR should prevail.

The CTA en banc quoted and affirmed the decision of the Court in Division as follows:

“‘Scrap’ is a term used to describe manufactured articles or parts rejected or discarded and useful only as material for reprocessing: especially waste and discarded metal (Webster’s New Collegiate Dictionary, 1977 edition). In other words, these scrap materials are recoverable wastes, where the proceeds derived from the sale thereof shall be taxed in accordance with the applicable provisions of the NIRC of 1997 referred to under Section 8, Rule VIII, Part V of the PEZA Rules.

But what is Section 8, Rule VIII, Part V of the PEZA Rules all about?

Section 8 reads as follows:

SEC. 8. Rejects, Seconds and Recoverable Wastes. -- Subject to the provisions of Section 3 of this Rule, rejects, seconds and recoverable wastes shall, when taken from the restricted areas of the ECOZONES to the customs territory, or to the non-restricted areas of the ECOZONE, be taxed in accordance with the applicable provisions of the customs and internal revenue laws and regulations of the Philippines.

The Section should be read in the whole context of Rule VIII.

Rule VIII is entitled “Tax Treatment of Merchandise in the Restricted Areas of the Ecozones”. Section 1 rules that merchandise brought to the restricted areas shall not be subject to all customs and internal revenue laws and regulations of the Philippines nor to local tax ordinance s. Section 2 mentions that domestic merchandise sent from the restricted areas to the custom territory shall be subject to the internal revenue laws of the Philippines as domestic goods sold, transferred or disposed of for local consumption. Section 3 provides that domestic merchandise on which all internal revenue taxes have been paid if subject thereto, and foreign merchandise on which duty or tax has been paid, may be taken into restricted areas from the customs territory and brought back thereto free of quota, duty or tax.

Clearly, Rule VIII governs only the movement of goods in and out of the restricted areas of the ecozones. And when one talks about taxes on movement of goods across customs territories, the taxes that are involved should only be value-added tax, excise tax and customs duties. Hence, when the Section 8 mentions “applicable provisions of the customs and internal revenue laws and regulations of the Philippines,” this should only refer to provisions on VAT, excise taxes and customs duties.

Not income taxes.

It is understandable that the rules would be particularly concerned about movement of goods, especially from within the zone to the customs territory because of the incentives.

We should note that there are separate rules in the IRR that govern the taxation of income of PEZA enterprises and these are the rules that should be applied on whether or not income from sale of scrap should be under incentives or the regular rates.

The income from the sale of scrap may, on the other hand, be considered as just a recovery of an amount previously expensed and subsequently recovered. Note that the cost of the original materials which are the sources of the scraps were expensed as part of the registered activity and therefore gave the company a tax benefit based only the 5% gross income tax, or no benefit at all if the company is under income tax holiday. Hence, if company was able to sell the scrap and recover part of the amount that has been previously expensed, the tax on the income should not exceed the benefit earlier enjoyed from the expense. This principle was applied when, some years ago, the Bureau of Internal Revenue allowed that Meralco refunds received by PEZA companies be taxed, not at the regular income tax, but at the rate applicable when the cost of the electricity which was refunded was claimed as expense.

Lingering thoughts.

I’m sure you have lots of these.

I thought by writing this and sharing with you, I can temporarily put these lingering thoughts to rest. This, of course doesn’t stop me hoping that the issues will later be finally put to rest. Happily, forever.

Lina P. Figueroa

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